Transcript The Long-Run Industry Supply Curve

ECONOMICS
SECOND EDITION in MODULES
Paul Krugman | Robin Wells
with Margaret Ray and David Anderson
MODULE 24 (60)
Long-Run Outcomes in Perfect Competition
Krugman/Wells
• Why industry behavior differs
in the short run and the long
run
• What determines the industry
supply curve in both the short
run and the long run
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The Short-Run Individual
Supply Curve
The short-run individual supply
curve shows how an individual
producer’s optimal output quantity
depends on the market price, taking
fixed cost as given.
Price, cost
of bushel
Short-run individual
supply curve
MC
Shutdown
price
$18
16
14
12
10
0
ATC
E
AVC
B
C
A
1
2
3 3.5 4
Minimum average
variable cost
5
6
A firm will cease
production in the
short run if the
market price falls
below the shutdown price, which
is equal to
minimum average
variable cost.
7
Quantity of tomatoes (bushels)
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Industry Supply Curve
• The industry supply curve shows the relationship
between the price of a good and the total output of
the industry as a whole.
• The short-run industry supply curve shows how the
quantity supplied by an industry depends on the
market price given a fixed number of producers.
• There is a short-run market equilibrium when the
quantity supplied equals the quantity demanded,
taking the number of producers as given.
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The Short-Run Market Equilibrium
The short-run industry supply curve
shows how the quantity supplied by an
industry depends on the market price
given a fixed number of producers.
Price, cost
of bushel
Short-run industry
supply curve, S
$26
22
E
Market 18
price
MKT
D
14
Shut- 10
down
price
0
200
300
400
500
600
There is a short-run
market equilibrium
when the quantity
supplied equals the
quantity demanded,
taking the number of
producers as given.
700
Quantity of tomatoes (bushels)
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The Long-Run Industry Supply Curve
• A market is in long-run market equilibrium when the
quantity supplied equals the quantity demanded,
given that sufficient time has elapsed for entry into
and exit from the industry to occur.
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Profitability and the Market Price
(b) Individual Firm
(a) Market
Price, cost
of bushel
S
S
1
E
MKT
$18
S
2
3
Price, cost
of bushel
MC
$18
E
A
D
16
16
MKT
ATC
D
B
14.40
C
14
0
500
MKT
D
Break- 14
even
price
750
1,000
Quantity of tomatoes (bushels)
C
0
3
Y
Z
4 4.5 5
6
Quantity of tomatoes (bushels)
A market is in long-run market equilibrium when the quantity supplied equals the quantity
demanded, given that sufficient time has elapsed for entry into and exit from the industry to
occur.
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The Effect of an Increase in Demand
in the Short Run and the Long Run
(a) Existing Firm Response to
Increase in Demand
Price,
cost
0
Price,
cost
Price
An increase in
demand raises
price and profit.
$18
14
(b) Short-Run and Long-Run
Market Response to
Increase in Demand
Y
S
MC
ATC
X
Y
X
Quantity 0
The LRS shows how the quantity
supplied responds to the price
once producers have had time to
enter or exit the industry.
1
LRS S
(c) Existing Firm Response to
New Entrants
Higher industry output from
new entrants drive price and
profit back down.
MC
2
Y
MKT
Z
MKT
QXQY
D
MKT 2
D
1
QZ Quantity 0
ATC
Z
Quantity
Increase in
output from
new entrants.
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Comparing the Short-Run and
Long-Run Industry Supply Curves
Price
Short-run industry
supply curve, S
A fall
in price
induces
existing
producer
A higher
price
attracts
new entrants
to in
exit
inlong
the long
generating
a fall
the
run, run,
resulting
in a rise
in
in industry output and lower
a rise in
price.
price.
Long-run
industry supply
curve, LRS
The long-run industry supply
curve is always flatter – more
elastic than the short-run
industry supply curve.
Quantity
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The Cost of Production and
Efficiency in the Long-Run
Equilibrium
• In a perfectly competitive industry in equilibrium, the
value of marginal cost is the same for all firms.
• In a perfectly competitive industry with free entry
and exit, each firm will have zero economic profits in
long-run equilibrium.
• The long-run market equilibrium of a perfectly
competitive industry is efficient: no mutually
beneficial transactions go unexploited.
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A Crushing Reversal
• Starting in the mid-1990s, Americans began drinking a lot
more wine.
• At first, the increase in wine demand led to sharply higher
prices.
• As a result, there was a rapid expansion of the industry.
• The result was predictable: the price of grapes fell as the
supply curve shifted out.
• As demand growth slowed in 2002, prices plunged by 17%.
• The effect was to end the California wine industry’s
expansion.
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1. The industry supply curve depends on the time period.
2. The short-run industry supply curve is the industry supply
curve given that the number of firms is fixed.
3. The short-run market equilibrium is given by the intersection
of the short-run industry supply curve and the demand curve.
4. The long-run industry supply curve is the industry supply
curve given sufficient time for entry into and exit from the
industry.
5. In the long-run market equilibrium—given by the intersection
of the long-run industry supply curve and the demand curve—
no producer has an incentive to enter or exit.
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6. The long-run industry supply curve is often horizontal. It may
slope upward if there is limited supply of an input. It is always
more elastic than the short-run industry supply curve.
7. In the long-run market equilibrium of a competitive industry,
profit maximization leads each firm to produce at the same
marginal cost, which is equal to market price.
8. Free entry and exit means that each firm earns zero economic
profit—producing the output corresponding to its minimum
average total cost. So the total cost of production of an
industry’s output is minimized.
9. The outcome is efficient because every consumer with a
willingness to pay greater than or equal to marginal cost gets
the good.
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